Audit firm legal form and fraudulent financial reporting

• Main Authors: CHEN, Chih-Ying, Chin, Chen-Lung, CHI, Hsin-Yi
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2010
• Subjects: Accounting; Business Law, Public Responsibility, and Ethics; Corporate Finance
• Online Access: https://ink.library.smu.edu.sg/soa_research/854; http://www.business.illinois.edu/accountancy/research/vkzcenter/conferences/taiwan/papers/Chen_Chin_Chi.pdf
• Institution: Singapore Management University

In China, audit firms can be formed as either unlimited liability partnerships or limited liability corporations. While the limited liability form of audit firms dominates the Chinese audit market, the unlimited liability partnerships still audit between 10 and 15 percent of the listed companies. This unique setting provides an opportunity for exploring the relation between audit firm legal form and audit quality. We investigate this relation for a sample of Chinese listed companies during the 2000-2004 period. We use the likelihood of client fraudulent financial reporting as a proxy for audit quality and find that the likelihood is higher for the clients of the limited liability audit firms than for the clients of the unlimited liability partnerships. The difference in the likelihood of fraudulent financial reporting between the two types of audit clients is greater in provinces where the legal environment is stronger. Overall, the results suggest lower audit quality for the limited liability audit firms than for the unlimited liability partnerships.